Hey guys, I'm not sure where else to ask for guidance on this. So here we go

CFA level 2, Alternative investments - Private real estate investment:



I've been confused about this equation here and here's where I've gotten so far.

*The growth rate is where it becomes confusing to me. I've listed down 4 scenarios here.





Cap rate = This year's rate of return = NOI/Property value

Discount rate = Investor's rate of return

Growth rate = (1)Growth in NOI? (2)Growth in Property value? (3)Growth in both NOI & Property value? (4) Growth in NOI based on Property value?





Calculation assumptions:

NOI = $100,000.00

Property value = $ 1,000,000.00

Cap rate = $100k/$1mil = 10%

Let Growth rate= 2%

So Discount rate should be 12%



(Scenario 1) Growth in NOI (quoted from Kaplan Schweser's Book 5 example)

NOI*1.02=$100k*1.02=$102k

However, at T1, this would become 10.2% rate of return instead of 12% (as implied by the discount rate)



(Scenario 2) Growth in Property value ONLY.

Property value*1.02=$1mil*1.02=$1,020,000.00

At T1, this would indeed result in a rate of return of 12% ($100k NOI + $20k increase in Property value). However, the CFA official curriculum stated quote "If the income and value for a property are expected to change over time at the same compound rate". Hence, the NOI will have to increase by 2% as well and this will result in the discount rate becoming more than 12%



(Scenario 3) To fulfil the CFA official curriculum's definition, I then tried to do a 2% increase for both.

NOI*1.02=$100k*1.02=$102k

Property value*1.02=$1mil*1.02=$1,020,000.00

Total return = $22k.

However, as the initial investment amount is 1mil exactly, I took $22k/$1mil = 2.2%

In this case, 2.2%+cap rate of 10% = discount rate of 12.2%



(Scenario 4) Growth in NOI based on Property value

2% growth in NOI in terms of Property value = 0.02*$1mil=$20k

At T1, NOI = $100k+$20k=$120k

Hence, Growth rate = $20k/$1mil = 2%; subsequently

discount rate = 2%+ cap rate of 10% = 12%

However, if Scenario 4 is indeed how we calculate growth rate, shouldn't the CFA official curriculum and Kaplan specifically mention it? Hence, I'm doubtful of scenario 4 as well.



In a nutshell, I still have no idea as to how

Cap rate + Growth Rate can be equal to Discount Rate....